Unclaimed Dollars

Ted Schroeder, PhD Kansas State University

Thu, 2001-02-15 12:00

If you produce quality cattle, you could be leaving money on the table by selling on the averages. With an average of $30/head pricing error when fed cattle are sold via live weight or dressed weight methods relative to grids, incentives for adopting new pricing and marketing methods are significant. Selling fed cattle based on average live or dressed weight prevents important pricing signals from

If you produce quality cattle, you could be leaving money on the table by selling on the averages.

With an average of $30/head pricing error when fed cattle are sold via live weight or dressed weight methods relative to grids, incentives for adopting new pricing and marketing methods are significant.

Selling fed cattle based on average live or dressed weight prevents important pricing signals from being passed from packers down to feeders and ultimately to cow/calf producers.

Pricing cattle on the average, a common method of selling cattle for decades, refers to all finished animals in a pen receiving the same price. It also refers to pens of cattle sold on a particular day in a given region of the country bringing prices within a narrow band of each other.

It's a relatively simple pricing method and doesn't require a lot of information by either the buyer or the seller. Average pricing, however, penalizes producers of high-quality cattle and benefits those with low-quality cattle. It's also detrimental to the beef industry.

Producers of high-quality cattle who want to receive their cattle's added value need to move from average pricing to value-based pricing where price received is based on the merit of each carcass.

A recent Kansas State University study looked at the amount of money producers of high-quality cattle were losing as a result of pricing cattle on average live or dressed weight prices. The study looked at 71 pens of cattle — a total of 11,703 head — produced and marketed in 1997 under a grid pricing marketing agreement with a large Midwest packer.

Each pen of cattle had packer kill sheets indicating slaughter date, overall revenue, price received for each carcass, and individual carcass weight, quality grade, yield grade and “out” carcasses. In addition, pen-average dressing percentages and total pen live weights were available.

The grid system under which these cattle were produced and sold had a base price for Choice Yield Grade (YG) 3 fed cattle based on a local USDA market quoted price. The discount for Select quality grade and lower followed the USDA boxed beef Choice-to-Select carcass price spread.

The grid offered modest premiums for Prime relative to Choice and no premiums for cattle fitting certified programs (i.e., Certified Angus Beef). Typical premiums for YG 1-2 relative to YG 3 cattle and common time-varying discounts for YG 4-5 cattle were offered under this grid.

The discounts for light-weight, heavy-weight and “out” carcasses were comparable with other grids. The cattle in this study were from a single feeding operation. As such, they're not necessarily representative of typical pens of cattle marketed on any given day across the nation.

The 71 pens of cattle were sold under three pricing methods to determine differences in prices received by various methods:

Live weight fed cattle prices,

Dressed weight prices and

Actual grid prices received.

The cattle graded 65% Choice or higher with a few “out” types of cattle. There were 40% YG 1 and 2 and 43% YG 3, with a few YG 4 and 5. Fourteen had carcasses less than 525 lbs., while 219 weighed more than 950 lbs. Average carcass weight was 798 lbs. with a 63.6 average dressing percent.

Value Of Information And Sorting

To determine the value to the cattle owner of information on cattle quality traits, each carcass was priced using the method that resulted in the highest price among the three alternatives (live, dressed or grid). If the cattle were sold using the method that resulted in the highest price for each carcass, the overall average price would have been $68.37/cwt., $1.21/cwt. more than selling all cattle on the next highest average pricing method (dressed weight).

Selling cattle using the method with the highest price resulted in 198 head (2%) sold on a live weight basis, 5,401 (46%) on a dressed weight basis and 6,104 (52%) head using the grid pricing system.

Selling all carcasses using the pricing method with the highest price increased total revenue:

by $406,590 ($34.74/head) relative to selling all cattle using live-weight pricing;

by $177,171 ($15.14/head) compared to selling all on a dressed-weight basis; and

by $218,455 ($18.67/head) compared to selling all on the grid (See Fig. 1 on page 21).

Thus, there is considerable value in understanding cattle quality and properly marketing cattle by the method returning the highest price, compared to selling all cattle using the same method, be it by live weight, dressed weight or grid.

Based on these results, considerable value is being lost in this industry. Someone will find a way to more efficiently increase the flow of information to claim that lost value. If producers don't do it, then vertical integration is likely to increase in cattle feeding and beef packing.

To the extent cattle producers prefer less integration, they have perhaps even more incentive to invest in technology to better identify and predict animal quality than these estimates suggest.

This represents short-term value of information. Long-term value is influenced by management changes made in response to information.

This analysis demonstrates the worth of information if a producer was sorting and selling cattle via different methods. This is not, however, a recommended cattle production and marketing management strategy.

Over the long run, producers will perform better if they find grid pricing alternatives that best fit their genetics, production system and marketing program. This is a long-term process.

Most producers will not succeed in targeting pens of cattle or even individual animals to different selling methods (live weight, dressed weight or grid) or even to different grids. Considerable learning is involved in collecting and using information and adjusting management and marketing accordingly for cattle sold under a grid.

So, what's the value of pricing cattle on a grid rather than by live or dressed weight pricing? We compared the carcass revenue received under each pricing method.

Let's assume the grid price fully reflects market value of the carcass (or at least market value for that grid). Then, any carcass that sells for a higher price brings more than it is worth and any carcass that sells for less is under-priced. This is what many argue is the case of poor-quality cattle being subsidized by higher-quality cattle when cattle are sold live or dressed with little price difference for levels of quality.

To determine the amount that cattle were “over-priced” or “under-priced” relative to the grid price, the difference in revenue from selling cattle on the grid relative to live or dressed weight was computed.

Remember that pricing these cattle on a different grid could result in different estimates of pricing error. Grids vary in their premium/discount structures.

Table 1 (above) presents amounts of “over-pricing” or “under-pricing” had our 11,703 cattle been sold live or dressed weight instead of on a grid.

For 3,650 of the cattle, the grid price was less than the live weight price by $2.90/cwt. or $36.80/head. This means these cattle if sold live would have received $134,335 more than their actual worth.

For the remaining 8,053 head, the grid price exceeded the live weight price. If these cattle were sold live instead of on the grid they would have received $322,442 ($40.04/head) less than they were worth.

Similar magnitudes of pricing errors were present for dressed pricing relative to grid pricing. The primary conclusion is if these cattle were sold via live- or dressed-weight pricing, assuming the grid pricing system is the most efficient in terms of sending appropriate price signals, this would have resulted in average “pricing error”(positive or negative) of more than $30/head.

Table 1. Magnitude of pricing error from selling cattle on a live weight or dressed weight basis instead of a grid (11,703 head of cattle marketed weekly during 1997).

Revenue Comparison

Number of Cattle (head)

Average Price Difference ($/cwt. live wt.)

Average Revenue Difference ($/head)

Total Revenue Difference ($)

Grid Less than Live Weight Revenue

3,650

-$2.90

-$36.80

-$134,335

Grid Exceeds Live Weight Revenue

8,053

$3.20

$40.04

$322,442

Grid Less than Dressed Weight Revenue

5,521

-$3.11

-$39.38

-$217,435

Grid Exceeds Dressed Weight Revenue

6,182

$2.28

$28.49

$176,150

The pricing error ranged from in excess of $150/head under-priced to more than $150/head over-priced. That means a $300/head value range existed across carcasses when sold on a grid that was not reflected in average live weight or dressed weight sales.

Producer Implications

Cow/calf producers can increase profitability by being rewarded for the value they add to their calves. When fed cattle are sold using average live weight or dressed weight methods, nearly no signal is sent to either the producers striving to produce higher quality calves or to producers who pay little attention to improving the quality of their cattle. This is true whether the producer retains ownership or sells the calves as feeders.

If a particular calf is worth $20/head more than another calf when finished because of quality traits developed by the cow/calf producer, it's also worth $20/head more when sold by the producer. Similarly, if an animal is worth $20/head less when finished, it was worth $20/head less as a calf.

The challenge is to develop a market information system that recognizes these value differences and gets the $20/head back to the producer that generated the added value while paying the $20/head lower prices for lower quality animals.

To do this, fed cattle need to be sold on a grid that identifies and pays accurate value for finished animals. Second, cow/calf producers need to ensure they get information and value passed back to them. The producer can do this either by retaining ownership of animals through finishing or by developing some other kind of vertical alliance to guarantee them this value differential.

To be successful in this strategy, cow/calf producers must have detailed information about their calves' probable performance to make production and marketing decisions. With an average of $30/head pricing error when fed cattle are sold via live weight or dressed weight methods relative to grids, incentives for adopting new pricing and marketing methods are significant.

With this reward potential, comes increased risk and a need for intensive management. Detailed information is needed to reduce the chances of adverse outcomes and enable producers to make more informed production, management and marketing decisions.

Ted Schroeder is a Kansas State University agricultural economist in Manhattan. Phone: 785/532-4488; e-mail: tschroed@agecon.ksu.edu.